Investing in a Low Growth Environment
August 13, 2015
We are sometimes asked by an arts organization why the 2015 income paid from their endowment was 4.5%, when the Foundation earned investment returns of almost 14% for the year. There are two answers to the question:
- Our investment policy goal is to earn returns ( interest, dividends, capital gains ) that allow for consistency in income payments year over year. In years where portfolio returns are particularly strong, we ‘bank’ some of that return so as to be able to keep income distributions stable against years where returns are lower/more volatile. The Board takes a long term view and considers long term results as well as short term returns making the annual payout decision. In 2014, one year returns were almost 14%, but looking at 10 year Foundation investment returns, the average is closer to 7%. An income return of 4.5% is in our view, reasonable and allows for a reserve (“cushion”) to cover future inflation and periods where markets are volatile or returns are lower.
- The second reason is that the Board and our investment managers believe that the double digit investment returns of the past 3 to 5 years are not likely to continue.
Lower Investment Returns
Opinions will always vary, but there is a common view that suggests the world is moving, over the next 3 to 5 years to an environment of lower investment returns. Slower global economic growth, appears to be the new norm. This results from continued high levels of government and household debt, aging demographics as boomers retire (they save more and spend less which impacts government tax revenues), and slower transitioning of emerging economies. After a period of years where interest rates have been at low to near zero levels, it is anticipated the US Federal Reserve will begin to slowly increase interest rates in 2015. The increases are expected to be small and Canada will likely lag moves in the US. Canada’s economic growth is more mixed than the US, due to challenges faced by an energy and commodity led economy.
The US economy remains a global driver and is slowly improving, but at a slow pace. As it strengthens, US interest rates are expected to rise. High equity returns of the past 3 to 5 years have resulted in high asset valuations. Our managers don’t see this as sustainable. The likely outcome, in the near term are positive equity returns, but at lower levels closer to a 10 year average of 5 to 7%. Our expectation is that the managers the Foundation employs will achieve, and exceed those returns.
We believe that equity and fixed income markets will deliver positive, but lower total returns in 2015 and for the next 3 to 5 years. Our strategy and asset allocation policy continues to be biased towards equities, and is focused on high quality companies, well managed, holding conservative balance sheets and a history of generating positive returns.
We believe the beneficiaries of endowments want their capital to be protected, to grow and to deliver a sustained level of income. In times where other sources of income to an arts organization are more variable, this stability is important and a comfort as an organization builds its future arts programming.